Getting personal loans from family and friends can be a relationship-wrecker if you are cavalier about repayments.
By: Phoenix Lee/
You may have skirted getting personal loans from the banks by getting a loan from family or friends, but you should still treat the situation as strictly business. Putting the agreement in writing not only protects both parties but also your relationship. After all, borrowing money from your family or friends is not the same as borrowing the car, and is still considered personal loans.
First, you must state how much money you need, what you’ll use it for and how you’ll pay it back. Next, draw up the legal papers–an agreement stating that the person will indeed put money into the business.
Too frequently, business owners fail to take the time to figure out exactly what kind of paperwork should be completed when getting personal loans from family or friends.
Your loan agreement needs to specify whether the loan is secured (that is, the lender holds title to part of your property) or unsecured, what the payments will be, when they’re due and what the interest is. If the money is in the form of an investment, you have to establish whether the business is a partnership or corporation, and what role, if any, the investor will play.
To be sure you and your family and friends have a clear idea of what financial obligations are being created, you have a mutual responsibility to make sure everyone is informed about the process and decide together how best to proceed. Most importantly, you shouldutline the legal responsibilities of both parties and when and how the money should be paid back.
Whichever route you take in getting personal loans, make sure the agreement is in writing if you expect it to be binding.
If such personal loans are not documented, you put both yourselves as well as the lender in a position with no legal recourse in case something goes wrong somewhere down the road. If your friend or family member wants to give you a no-interest loan, make sure the loan is not a very large amount.
Keep in mind that if you don’t put all the details of the loan in writing, it will be very difficult for you to deduct the interest you pay on it. To be absolutely safe, you should consider making the friend or relative from whom you are getting personal loans from, one of the business’ shareholders.
This effectively makes the transaction an investment in your company and also makes it easier from a tax standpoint for your friend or relative to write off the transaction as an ordinary loss if the business fails.
In addition, if your company is wildly successful, your relative will have an equity interest in the business, and his or her original investment will be worth quite a bit more. In contrast, if a relative gives you a loan and your company goes under, the relative’s loss would generally be considered a personal bad debt.
Making your relative a shareholder doesn’t mean you’ll have to put up with Mom or Pop in the business. Depending on your company’s organisational structure, your friend or relative can be a silent partner if your company is set up as a partnership, or a silent shareholder if you are organized as an private limited company or limited liability company.
Even with every detail documented, your responsibilities are far from over. When getting personal loans, don’t make assumptions or take people for granted just because they are friends or family members. Communication is key.
If your relative or friend is not actively involved in the business, make sure you contact him or her once every month or two to explain how the business is going. When people invest in small businesses, it often becomes sort of their pet project. So, it is important to take the time to keep them informed.
And, of course, there are the payments. Though friends or relatives who invest in your business understand the risks, you must never take the loan for granted. Don’t be cavalier about paying the money back after getting personal loans. That kind of attitude could ruin the relationship.
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